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PA Supreme Court: Insured can recover for settlement made without insurer's consent where defense provided under a reservation of rights if settlement is for a covered claim and proven "fair, reasonable, and non-collusive"

In Babcock & Wilcox Co. v. Am. Nuclear Insurers, No. 2 WAP 2014, 2015 Pa. LEXIS 1551 (Pa. July 21, 2015), the Supreme Court of Pennsylvania, in a case of first impression, held that an insured does not breach the insurance contract and can recover from its insurer when it settles a case where the insurer defends the insured subject to a reservation of rights but refuses to consent to the settlement, so long as the insured demonstrates that the settlement was for a covered claim and was fair, reasonable, and non-collusive. In doing so, the Court rejected the insurer's contention that the insured must prove the higher burden of bad faith by the insurer in order to recover for a settlement without the insurer's consent.

Babcock & Wilcox Co. and Atlantic Richfield Co. (collectively the "Insureds") were sued in a class action by hundreds of plaintiffs alleging bodily injury and property damage from emissions from nuclear facilities owned by the Insureds (the "Underlying Action"). American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters (collectively "Insurer") agreed to defend Insureds in the Underlying Action subject to a reservation of rights which disputed whether the policy covered certain aspects of the underlying claims. Settlement offers were presented to Insurer, but it refused to consent believing there was a strong likelihood of a defense verdict given the lack of medical and scientific support for the plaintiffs' claims and favorable decisions for Insureds on procedural and evidentiary issues. After being denied consent, Insureds proceeded to settle the Underlying Action on their own for $80 million, which was less than the $320 million in potential coverage available from Insurer.

Insureds subsequently sought reimbursement in a coverage action. Insurer contested reimbursement on grounds that Insureds failed to obtain Insurer's consent to settle pursuant to a "consent to settlement clause" which gave Insurer sole discretion to settle any claim or suit. The trial court in the coverage action adopted a test proffered by Insureds and derived from the case of United Services Auto. Ass'n v. Morris, 741 P.2d 246 (Ariz. 1987), that "an insurer, defending subject to a reservation of rights, is required to reimburse an insured for a settlement reached in violation of the consent to settle clause where coverage is found to exist and the settlement is 'fair and reasonable' and made in 'good faith without collusion.'" Babcock & Wilcox Co., No. 2 WAP 2014, 2015 Pa. Lexis 1551 at *8 (citing trial court opinion). In doing so, the trial court rejected Insurer's argument that it could only be required to pay the settlement if the insurer acted in bad faith pursuant to the standard set forth in Cowden v. Aetna Cas. & Sur. Co., 134 A.2d 223 (Pa. 1957). A jury trial was subsequently held and the jury found that Insureds' settlement with plaintiffs in the Underlying Action was fair and reasonable.

On appeal, the Superior Court reversed, finding that neither the Morris "fair and reasonable" standard nor the Cowden "bad faith" standard were appropriate, instead adopting a third approach derived from Taylor v. Safeco Ins. Co., 361 So. 2d 743 (Fla. Dist. Ct. App. 1978), which provided the insured with two options in the event an insurer defends subject to a reservation of rights: 1) the insured may accept the defense, in which case it must comply with the consent to settlement provision of the policy and its only recourse from the insurer's conduct during the defense is the bad faith standard set forth in Cowden, or 2) the insured may reject the insurer's defense and defend itself at its own expense, in which case the insured controls the decision to settle and, should coverage be found, the insured may recover its defense costs and the settlement amount from the insurer to the extent they are fair, reasonable, and non-collusive. The Superior Court remanded for a new trial applying this test.

The Supreme Court of Pennsylvania granted review to consider the issue of whether "an insured forfeits the right to insurance coverage when it settles a lawsuit without the insurer's consent, where the insurer has defended the suit subject to a reservation of rights." Babcock & Wilcox Co., No. 2 WAP 2014, 2015 Pa. Lexis 1551 at *14. In a 3-2 decision, the Supreme Court reversed the Superior Court and held that the trial court applied the appropriate standard.

The majority opinion, written by Justice Baer, first rejected the two-part test adopted by the Superior Court for two reasons: 1) Pennsylvania law does not give the insured the option of rejecting an insurer's defense as it would constitute a breach of the insurance contract; and 2) most insureds would not be able to utilize the test adopted by the Superior Court because they do not have the funds to pay for their own defense. The Court then looked to prior Pennsylvania decisions that addressed related scenarios -- namely, Cowden and Alfiero v. Berks Mut. Leasing Co., 500 A.2d 169 (Pa. Super. 1985) -- and approaches employed by other jurisdictions in considering the issue. Ultimately, the Court adopted a modified version of the "fair and reasonable" standard set forth in Morris, supra, "limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and, thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims." Babcock & Wilcox Co., No. 2 WAP 2014, 2015 Pa. LEXIS 1551 at *47. In rejecting the higher burden of bad faith set forth Cowden, the Court reasoned such a standard was appropriate in order to recover a verdict from the insurer in excess of policy limits, i.e., extra-contractual liability, but that the lower standard of proof of a fair and reasonable settlement was proper to seek reimbursement for a settlement within the contracted policy limits. Id. at *48 n. 18.

The Court stated that "a determination of whether the settlement is fair and reasonable necessarily entails consideration of the terms of the settlement, the strength of the insured's defense against the asserted claims, and whether there is any evidence of fraud or collusion on the part of the insured." Id. at *47-48. The Court further explained that whether settlement was fair and reasonable must be looked at "from the perspective of a reasonably prudent person in the same position of the [Insureds] and in light of the totality of the circumstances." Id. at *50. Finding that the trial court properly applied this standard, the judgment was reinstated.

Importantly, in footnote 14 the Court stated that the issues presented in this case "only arise in a subset of reservation of rights cases" where the interests of the insured and insurer are not aligned in considering settlement, which the Court noted is a rare occurrence. Moreover, in footnote 15 the Court indicated that the standard it adopted may not apply in all instances in which an insurer defends subject to a reservation of rights: "not all reservations of rights are equal .... The mere fact that an insurer restates that it will not cover what the insurance policy does not cover, where it arguably might be part of the damages sought, does not automatically result in allowing the insured to settle the entire suit. Parties and courts may need to consider whether a particular reservation of rights justifies diverging from the contract's cooperation clause, a question which is not squarely before this Court." Accordingly, the full scope of the Court's holding remains to be seen.

Justice Eakin issued a concurring and dissenting opinion, joined by Chief Justice Saylor, agreeing that the standard adopted by the Superior Court should be rejected, but arguing that the well-established standard for bad faith set forth in Cowden should apply. He further criticized the majority's rationale indicating that it "allows an insured to alter the nature of the bargain it struck with its insurer." Id. at *60.

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Firm shareholder Henry Sneath's article "The New Federal Defend Trade Secrets Act of 2016" was published in the 2016 Fall/Winter edition of USLAW Magazine.

Firm shareholder Henry Sneath's ed a CLE on the New Federal Defend Trade Secrets Act of 2016 for the Western Pennsylvania chapter of the Association of Corporate Counsel

Firm shareholder Alan Miller was named as the 2017 Best Lawyer Environmental Litigator of the Year and also was named a 2016 Super Lawyer in Insurance Coverage.

Firm shareholder Henry Sneath was named a 2016 Super Lawyer in Intellectual Property Litigation; firm shareholder Anthony Picadio was named a 2016 Super Lawyer in Business Litigation; firm associate Brandon McCullough was named a 2016 Super Lawyer Rising Star in Insurance Coverage.

On May 25, 2016, Firm shareholder Jeff Ludwikowski presented "Voir Dire and Jury Selection" with Honorable Ronald Folina, at the Crowne Plaza Pittsburgh, as part of the National Business Institute's Continuing Education Programs.

Firm shareholder Henry Sneath and firm associate led and presented at a 2-hour CLE on "Defend Trade Secrets Act (DTSA): The New Federal Private Cause of Action for Trade Secret Misappropriation."

Firm shareholder Kelly Williams spoke at the USLAW Business to Business Litigation Exchange in San Francisco on Prosecuting and Defending Business Defamation and Commercial Disparagement Claims by or Against Competitors Including Social Media Issues.

Firm shareholder Jeff Ludwikowski spoke on "Wacky Pennsylvania Construction Laws" at the U.S. Law Network Spring Conference in Rancho Palos Verdes California, which took place on April 7-9, 2016.

Firm shareholder Jeff Ludwikowski was selected to serve a two year term as Education Coordinator for the Construction Law Section of the U.S. Law Network.

Firm shareholder Bridget Gillespie and firm associate Brandon McCullough served as Regional Editors and Co-Authors of the Pennsylvania Chapter of the DRI Duty to Defend Compendium which was published in February 2016.

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